Inventory Carrying Costs: Significance, Components, Means, Functions

Inventory carrying costs comprise a number of different cost components and generally represent one of the highest costs in the physical distribution system. This, combined with the fact that inventory levels are influenced by the configuration of the logistics system, demonstrates the need for an accurate assessment of inventory carrying costs if the appropriate cost tradeoffs are to be made within the firm. Currently, most of the companies that consider the costs of holding inventory use estimates or traditional industry benchmarks. In fact, many corporations do not consider inventory carrying costs in decision making although such costs are substantial and real. Although a number of authors have addressed the types of costs that should be considered and have estimated that such costs range from 12% to 35%, there is not a generally accepted methodology for determining inventory carrying costs or for that matter even a framework for developing such costs. The purpose of this article is to present a methodology, based on existing literature in the fields of accounting, distribution and production, that can be used by managers to determine the cost of carrying inventory for their companies. In addition to providing a framework that can be applied in the “real world”, some specific uses for the inventory carrying cost figure are explored.